An Insurance Storm

One month into hurricane season, commercial property owners along the Gulf and Florida coasts are coming to grips with the jaw-dropping costs of insuring against future hurricanes.

The reason is simple: Property and casualty insurers are smarting from last year's record $46 billion in hurricane-related losses. Insurers are also increasingly cautious about underwriting coastal hurricane risk as ratings agencies and securities analysts stand ready to downgrade them for excessive catastrophic risk exposure.

“The overall supply of hurricane- risk insurance for Florida properties has declined by 70% over the past 12 months,” says Kevin Madden, managing director of the real estate practice at risk management firm Aon Corp. “And, if more storms come along in the next few years, that could convince insurers to cut back on their hurricane exposure even more.”

The end result for policyholders with hurricane-prone portfolios is soaring premiums and deductibles on their property and casualty insurance. The National Multi Housing Council (NMHC) reports that insurance premiums on many coastal portfolios have jumped by as much as 400% over the past eight months. Hurricane experts expect five powerful hurricanes to develop this year, but there can be no certainty if any will hit the U.S. mainland. As one insurance broker puts it, if you own wind-exposed assets along the southern coast, “your premiums have gone up, and will likely go up even more.”

Gun-shy risk underwriting

Navigating this new insurance climate will be a challenge for many coastal policyholders. Not buying any coverage isn't an option since most commercial real estate lenders demand that borrowers secure adequate property and casualty insurance.

In Florida, most policyholders were paying as much as 3% of their property's total insured value (TIV) in deductibles last year. The TIV is equal to the replacement value of the property. In 2005, insurers viewed that 3% as an acceptable price for coastal hurricane risk. But that percentage has risen as high as 10% of TIV as of June, says Madden, and he doubts that prices have crested.

Pricing is just part of the problem. Manhattan-based Fitch Ratings reports that vital coverage such as windstorm insurance may become commercially unavailable in places like coastal Florida, which sounds eerily similar to the sudden lack of terrorism insurance after the 9/11 attacks.

Windstorm used to be lumped into most catastrophic property and casualty policies. Earlier this year, however, many insurers started carving out windstorm coverage for an additional cost. Many simply excluded it from their policies altogether.

“It's a difficult insurance climate because carriers are placing more risk on their policyholders,” says Rick Campo, CEO at Houston-based apartment REIT Camden Property Trust. Camden owns a $7 billion apartment portfolio scattered across the Sunbelt and Midwest. Many of Camden's properties are high-rise complexes in Houston and along the Gulf Coast.

“After I renewed our [property and casualty] policy in April, our catastrophic risk coverage dropped substantially and our wind coverage got excluded. It changed very quickly from last year,” says Campo, whose company has a 13-year claims history with some insurers. Despite last year's record number of 15 hurricanes, Campo says his portfolio didn't incur any storm-related claims.

Even so, none of his original insurers were willing to cover Camden's windstorm risk. Campo also says that under his April renewal contract, his total insured catastrophic losses are capped at $125 million. Last year, by comparison, his insurers were prepared to cover as much as $500 million in catastrophic losses. Consequently, Campo secured what he calls moderately priced stand-alone windstorm coverage from an offshore insurer earlier this year.

Flooding is another major concern for coastal portfolios. Yet flood insurance, which is offered by the federal government's National Flood Insurance Program, is typically excluded from most commercial policies.

The coverage tops out at a meager $500,000 for the property and another $500,000 for the property contents, though a bill in the House Committee on Financial Services was introduced at the end of last year to boost that coverage amount. That bill remained stalled as of late June.

Capital markets react

Insurance carriers are also under a microscope. Financial analysts and rating agencies are closely scrutinizing insurers' catastrophic risk profile on coastal policies. If a carrier is heavily exposed to hurricane losses, analysts want to ensure that policyholders are paying handsome premiums for this coverage.

Insurers believe that such protections are justified. Over the past 100 years, 80% of the catastrophes that have rattled the insurance markets (and left financially impaired carriers in their wake) have been hurricanes, according to insurance analyst A.M. Best Co. Prior to 2004, when storms in the current cycle began striking the U.S. with greater frequency and severity, most analysts weren't too concerned with this coastal windstorm exposure.

“The financial analysts not only want to know what each insurer's aggregate risk is in any given area, but they are willing to downgrade the carrier if it appears too concentrated,” says insurance broker Scott Allen of Marsh Inc.

Policyholders of thinly capitalized insurance companies will likely see their coverage dry up, if their carrier gets impaired by storm losses. Out of the 64 ratings downgrades that A.M. Best issued between September 2005 and April 2006, roughly 55% stemmed from hurricanes in 2004 and 2005.

Concerned that borrowers may not be able to cover their rising insurance deductibles, many CMBS servicers now require cash reserves to cover future increases. Property owners with smaller portfolios concentrated on the coast may be challenged to pass on these added insurance costs to their tenants.

“These higher costs will definitely put an added strain on property owners, which could increase the number of loan delinquencies,” says Zanda Lynn, managing director at Fitch Ratings.

Safety in numbers

Rising insurance costs have also highlighted the value of portfolio diversification and adequate disaster planning. Both, it turns out, might help mitigate this pricey new insurance climate. For Fort Worth-based REIT Crescent Real Estate Equities, portfolio diversification has helped keep its insurance costs from spiraling out of control. The company owns 31.2 million sq. ft. of office properties with 40% of that space tucked into the hurricane-prone Houston market. Four of Crescent's high-rise office towers are located in Miami.

“Two things have really helped us keep our premiums and deductibles from rising extremely high,” explains Randy Kostroske, vice president of risk management at Crescent Real Estate Equities. “We've got a large portfolio with properties on both coasts, and we've been very proactive with our carriers by conducting voluntary loss control surveys on all of our coastal properties.”

Loss control surveys are typically conducted by insurers before they agree to underwrite a large commercial property. Engineers inspect the entire property looking for structural weaknesses and potential life-safety issues, and their findings will ultimately affect the pricing on that policy.

Two years ago, for example, Kostroske renewed Crescent's blanket property and casualty insurance policy with a moderate 5% increase over the company's 2003 rate. More importantly, he also negotiated a flat deductible in November 2005 — less than one month after Hurricane Rita slammed into Texas. That particular storm left insurers with $2.2 billion in insured losses.

“I believe that strong ties with your insurance carrier can only bode well when it comes time to renew your policy,” says Kostroske. “If you don't have a formal business continuity plan, create one and tell your carrier how it will limit their losses.”

Crescent uses its own regional managers to police the portfolio. Kostroske says that each manager is responsible for drafting business continuity plans for each asset under his watch. These tailored plans outline how Crescent property managers should respond to a slew of disasters.

The goal, says Kostroske, is to ensure that properties don't remain closed for long periods of time. Formalizing the company's emergency protocols in advance only makes a portfolio less of a risk to insurers, he says. “Get your business continuity plan in writing. Get your property managers to go through checklists on emergency protocols,” says Kostroske.

Knowledge is power

Since insurers thrive on actuarial data, it also can't hurt for policyholders to voluntarily present claims and construction data to their insurers. The goodwill generated by such an effort may be its own reward, but this also helps insurers get a complete picture of what they are underwriting and why that portfolio may represent less of a risk than others.

Risk awareness is even seeping into the design phase of new construction. Developers in hurricane-prone areas are increasingly pushing hurricane-resistant building designs.

Some developers are even designing high-rise condominium towers on the Florida coast that can withstand hurricane-force 155 mph winds (see sidebar, p. 35). Only three Category 5 hurricanes with winds above 155 mph have made landfall in the U.S. since 1935.

Since high winds can hurl debris against buildings, risk managers suggest that coastal properties feature shatterproof glass. Much of the residual damage from last year's hurricanes was the result of shattered windows, which left many buildings exposed to the elements. Florida's building code requires that new projects with more than six stories use fortified glass.

Stormy outlook

Despite the best efforts of both property owners and developers, however, insuring storm-prone assets won't get any easier in the coming years. Whether this pricing climate represents a permanent shift in underwriting hurricane risk remains to be seen. One leading indicator may be the catastrophic risk modeling industry.

Insurers bank on these models. Catastrophic risk modeling firms such as Boston-based AIR Worldwide crunch more than 100 years of historical data to produce detailed near and long-term computer-modeled forecasts.

These models aren't always accurate — for example, none predicted that 2005 would see 26 named storms — but insurers rely on their actuarial data for risk underwriting.

According to Bob Hartwig, chief economist at the Manhattan-based Insurance Information Institute, a trade association, limited hurricane activity this year could have less of an effect on underwriting practices.

“The long-term risk models suggest that this cycle of more severe and frequent hurricanes will last at least another 10 to 20 years,” says Hartwig. “So, I wouldn't put too much stock in what happens this year.”

Parke M. Chapman is senior associate editor.

Wind-tunnel tests help put a ceiling on insurance rates

Many coastal developers use high-tech modeling software to gauge how their buildings would fare against hurricane-force winds. But Minneapolis-based high-rise developer Opus Group combines that regimen with standard wind-tunnel testing.

Unlike computer-generated models, tunnel tests apply real gusts to Fisher-Price-scale models. The result, say engineers, is an incredibly accurate glimpse of how violent winds will affect a property in the future.

Wind-tunnel tests on new projects can help convince insurers that the structure won't get blown away or split apart during a storm. That assurance can only help policyholders when it comes time to renew their property and casualty policies.

“In general, any kind of discretionary engineering [such as wind-tunnel testing] that is completed by a developer is definitely viewed favorably by insurers when they go to set pricing,” says Matt Walsh, managing director at insurance brokerage Aon Construction Services.

The first tunnel tests on commercial properties were conducted more than 20 years ago, but the recent spate of hurricanes has opened many developers' eyes to their value. After all, flimsy stucco ledges can become projectiles when blasted by 155 mph gusts.

“All buildings receive certain loads from the wind. This enables us to gauge how much load our building can absorb, plus how the adjacent buildings will affect the wind pattern,” says Darren Azdell, manager of design architecture at Opus. The giant developer has 35 million sq. ft. of commercial space in either the planning or construction stage, 10 million sq. ft. of which will be built between coastal Alabama and Fort Lauderdale.

Later this summer, Opus will complete its 29-story Parkshore Plaza project in St. Petersburg. The condo was originally slated to front the Gulf, but Azdell opted for an eastern site along the bay instead. Azdell says that wind-tunnel tests of a scale model revealed the need for impact-resistant laminated glass.

Azdell recalls a tunnel test years ago that involved a high-rise condo with a rooftop cooling tower. The tower was nearly blown off the roof by 155 mph winds. A computer-generated model might have missed that, says Azdell.

“A lot more firms are using the wind tunnels now, especially if they are building on the coast,” says Azdell, who has put his buildings through these tests since the 1980s. “It does cost more to do these tests, but we believe you can trim owners' insurance costs by doing them.”— Parke M. Chapman